The Hindu Business Line : Statutory warning

Like his predecessor in 1998, the late I. G. Patel, the current chairman of the Prime Minster’s Economic Advisory Council (EAC) is a former Governor of the Reserve Bank of India. So it is perhaps inevitable that Dr C. Rangarajan would view India’s economic outlook through the cautious eyes of a central banker who has to balance two apparently contradictory impulses — the urge to accelerate the key indicators and also keep an eye on the speedometer lest th e growth vehicle goes off the road. In its Economic Outlook for the year, the EAC reflects these twin concerns and is especially worried about the External Commercial Borrowings. The EAC’s caution however does not extend to the equity side, whether portfolio or direct investments. This is not by any means a ringing endorsement of sourcing because Dr Rangarajan warns companies against overseas sourcing of funds, in general, that would “bypass” domestic interest rate structures.

Most policymakers need to caution an exuberant economy only because history requires it. If India verged on global defaults in 1991, part of the reason lay in the uncontrolled foreign borrowings during the mid-1980s and the failure of the economy to live up to expectations. For the past five years, ECBs have found productive channels both in the domestic economy and in outbound capital flows. To that extent, the dangers of idle and expensive ECBs have been largely mitigated. But the Finance Ministry and the RBI have observed vulnerable spots and in early May applied brakes on the use of foreign debt for integrated townships. Now, the EAC would like the caution extended to ECBs, in general, warning that they ignore not just the domestic interest rate structure but the monetary policy framework even. Dr Rangarajan would thus like to use “non-discretionary” means to limit the end-use of ECBs.

It is unclear what rupee assets the surging ECBs will acquire bypassing domestic intermediaries, as the EAC fears. But one can expect some restraints as more Indian companies use the ECB route. The EAC reckons that such borrowings will jump to $20 billion from $16 billion in 2006-07 and just $2 billion in 2005-06. The report tones down growth forecasts a bit but the economy often proves most pundits wrong. But the EAC’s advice to the RBI to consider $25 billion a year as a safe addition to forex reserves is intriguing; one wonders why the tail wags the dog. Should not the financial system be enabled to absorb higher inflows while the going is good?

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